Thursday 29 October 2020

A case for privatizing govt assets in the region

, 29 days ago

By Wissam Haddad
Value added taxes, reduced energy and food subsidies, increased fees for entry visas and residence permits, consolidated government departments, deferred projects, tourism taxes, sin taxes on soft drinks and tobacco -- all are sources of additional revenue towards balancing fiscal budgets when the primary source i.e., crude, suffers a double hit – lower prices per barrel as well as lower global demand. 
Borrowing also takes center stage in this situation. Borrowing locally (and in local currency) can absorb the available liquidity so in most cases it is combined with borrowings in ‘hard currency’ (USD).  This is important as it attracts global funding and maintains sufficient foreign currency reserves to preserve the currency peg, stabilising inflation and attracting inward foreign direct investment.  
Increased borrowing can result in the global ratings agencies downgrading sovereign ratings as they project budget deficits between oil revenues and the operational, social and capital expenditures that are required.  With such ratings downgrade, borrowing becomes more expensive as higher interest must be offered to continue to attract global investors.  This higher interest places greater burdens on cash flows. To compensate, value add and other taxes are increased and subsidies reduced further, often slowing down economic growth at a time when it should be ramped up the most.  An economic downturn generally reduces budget contributions from taxes, fees and other charge sources.  
When a global pandemic hits, forcing increased spending to support pandemic hit sectors, what else can be done?  There are numerous answers but one avenue is the privatization of government-owned assets.  
Hospitals, schools, utilities, desalination plants, telecoms, real estate, ports, roads, social housing, correctional facilities, airports, and many other assets that are currently in the realm of the public sector can be sold to raise funding.  Privatization programs are typically controversial spurring much debate – how can assets that are considered the ‘crown jewels’ be sold (even partially) to a capitalistic entity, particularly a foreign entity? The short answer is through a number of privatization structures, many of which can allay these concerns.  
One of the largest and most recent privatizations took place in December 2019 with the partial sale (1.5%) of Saudi Aramco, the world’s second largest owner of crude oil reserves. The value of the asset, a whopping $1.7 trillion, meant that Saudi Arabia netted around $26 billion from the initial public offering (IPO) that was subscribed for from all over the world.  Furthermore, the government did not give up control as they remain the overwhelming majority owner with the ability to ‘tap’ the market through secondary offerings on their local exchange, the Tadawul, where Saudi Aramco shares are listed.  
In other programs, governments can privatise assets through term-limited ‘concessions’, as is the case with Bahrain’s only container terminal, the Khalifa Bin Salman Port.  In November 2006 the Government of Bahrain signed a 25-year concession agreement with Netherland’s-based APM Terminals BV, whereby APM would operate the port over the term and pay royalties and other fees to the government.  Here the government does not own any shares in the local port operator – APM Terminals Bahrain.  However, the government maintains control through strict regulatory oversight by its Ports & Maritime Authority and stringent requirements that are included as part of the concession agreement.  
The privatization of government assets is not an easy decision to make nor a simple process to carry out. Conflicts of interest, wide valuation expectations, procedural and legal impediments, social and employment considerations, public opinion and political sensitivities create significant barriers to success.  Think of government schools that offer free or heavily subsidised tuition – how can they be made attractive to private owners?  
One answer is through minimum off-take agreements, where the government guarantees a minimum purchase (or off-take) of services from the now-private entity for a specified period of time.  This structure is especially common in privatively developed utility companies, where the government buys a certain percentage of the utility’s output over say a 10 or 15-year period.  The benefit here to the government is clear – no initial capital outlay as the utility is built, owned and operated (BOO) by a private and specialised company, potentially saving the government hundreds of millions in cash flow that can be directed elsewhere.  
Bahrain used a similar structure for its Al Ezzel Power Plant which launched operations in 2006 and was developed by a global and local consortium.  Similar programs can also be structured under “build, own, operate, and transfer” (BOOT) where the asset is held under a form of leasehold structure that eventually transfers back to the government.  
So how serious are privatizations in the region going forward?  As a prime example, Saudi Arabia’s Vision 2030, an ambitious long-term plan for the kingdom’s future, published a detailed privatization book with its target sectors (including healthcare, education, renewable energy and recycling, and even parking lots among many others), target performance metrics including cash flow savings and job creation, and the required regulatory structures.  The establishment of a dedicated oversight body – The National Centre for Privatization and PPP (NCP) and the quick delivery of the Saudi Aramco IPO is proof of the seriousness and commitment to this program.  
The recent successful privatization of two of Saudi Arabia’s key flour mills to two private consortiums (Raha Al Safi Consortium and Al Rajhi Ghurair Masafi Consortium) on July 5, 2020 raised a total of SAR2.8 billion.  Two additional flour mill privatizations are also in the works as is the bidding for the private development of parking lots.
Bahrain has also been a frontrunner in regional privatizations with the privatized offering of public bus transportation in 2003, the 2010 partial sale through an IPO of Aluminum Bahrain (Alba), and another power and desalination plant - Al Dur – which has been operational since 2012.  
Bahrain’s own Economic Vision 2030, is focused on diversifying the kingdom away from oil and includes privatization as one of its main components.  Innovative public private partnerships (PPP) in the kingdom are also evident in its large-scale social housing programs, with the ‘Mazaya’ program providing private bank mortgage funding with government subsidized interest rates to qualifying buyers.  Another example of a successful PPP in Bahrain is the recent agreement with Italy’s Eni Group to explore a number of oil fields in the Kingdom. 
Regionally there are several successful examples PPP programs.  Dubai’s knack for entertainment saw the construction funding and development of its “Dubai Parks and Resorts” entertainment park in 2014 (today DXB Entertainment) through a widely subscribed IPO.  Similarly, the Abu Dhabi National Oil Company (Adnoc) sold 40% of its Adnoc Oil Pipelines (over a 23-year lease concession) to two global private equity houses – Blackrock and KKR – for $4 billion in 2018.
Pushing ahead with privatizations in the region seems inevitable.  Done transparently and with a clear strategy, these programs should continue to release billions of dollars to government reserves and encourage the development of social and hard infrastructure, creating much needed jobs.  The Government of Bahrain’s establishment of the Tender Board in 2003 and the National Audit Office in 2011 safeguards transparency and accountability – key pillars for privatizations.  Furthermore, reducing the role of regional governments from operators to regulators will not only relieve governments from the conflicted burden of being both operator and regulator, it will also create healthy competition, reduce prices and deliver better services to end users as the newly privatized assets are commercially managed by specialized operators with local, regional and/or global expertise. 
Finally, using IPO-based privatizations, where ownership in these assets is offered not just to large institutional operators but also to any individual wanting a share in the country’s crown jewels, not only deepens the country’s capital markets but also assists in the distribution of wealth to the wider population creating participation and increased support for such programs.
Wissam Haddad is Head of Investment Banking at SICO is a leading regional asset manager, broker, market maker and investment bank.


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